Discusses Chapter 11 bankruptcy issues and issues with business reorganization.

Tuesday, February 8, 2011

New Value Exception to the Absolute Priority Rule

As discussed earlier the Absolute Priority Rule is difficult to understand. It gets even more difficult to explain the New Value Exception because it first requires a clear understanding of what the APR means. The APR in a business case generally means that if the shareholders/owners of the company want to keep their ownership interest then all creditors, including unsecured creditors, must be paid in full.
One exception to the rule is of course to get the creditors to accept less than the full amount, which is possible in some situations. However what if the unsecured creditors are playing hard ball and refuse to accept less than 100% but the business cannot afford to pay the entire amount. That is where the New Value Exception comes into play.
The New Value Exception states that shareholders/owners can keep their ownership interest if they offer "new value". The Courts have interpreted the New Value Exception pretty consistently since 203 North LaSalle. In order for the shareholder/owner to keep their interest they have to give something to the company, normally cash, that is necessary for the effective reorganization. Also the process normally has to be open to outside bidders. Below is a brief scenario to help.
Bob owns an electronics store. Due to the economy Bob is forced to file Chapter 11 bankruptcy for Bob's Electronics. Bob has credit card debt as well as vendor debt. He proposes a Chapter 11 Plan of Reorganization that pays 50 cents on the dollar to unsecured creditors and of course the creditors object. Bob tries to obtain confirmation through the cramdown provisions of 1129. If the creditor objects and Bob is not willing to give "new value" then the APR stops confirmation and the case is doomed.
In order to get the case confirmed Bob will need to give "New Value". So if Bob proposes in the Chapter 11 Plan that he is going to give $50,000.00 to help fund the plan then he may meet the exception if the $50,000.00 is necessary and substantial for the situation. Also Bob would need to open up the bidding to see if some other party would be willing to give more than $50,000.00 for the same interest he is retaining. If Bob does this then the case can be confirmed through cramdown.
As you can probably tell the Absolute Priority Rule and the New Value Exception are complex situations that require specialized legal counsel. Please contact a local attorney that concentrates on Chapter 11 bankruptcy. If you need more information please feel free to call me at (904) 521-9868 or go to chapter11jax.com.

For more information on the New Value Exception go to: http://www.hollandhart.com/newsitem.cfm?ID=340